High Bids, High Rates and a Cause for Tears? What to Make of Chaotic Housing Market

A key in the lock of a residential front door

Though summer is a time of relaxation for many, the housing market remains anything but peaceful.

Rising mortgage interest rates, bidding wars, low inventory – it’s hardly a walk on the beach.

Zillow, the popular home searching website, recently released findings from a survey that show 50% of home buyers say the process left them in tears. Nearly 70% of respondents to Gallup’s annual Economy and Personal Finance Poll, conducted this spring, said now is a bad time to buy a home.

The numbers simply don’t lie. As of Wednesday, the average rate on a 30-year fixed mortgage was 5.55% – a roughly two percentage-point jump since January. Add on the supply chain issues, plus a recent report from real estate brokerage Redfin that cited nearly 60% of homes sold for more than their asking price in April, and you have a stressful environment for home buyers.

To help sort it all out, UVA Today caught up with a couple of experts from the University of Virginia’s McIntire School of Commerce – Drew Sanderford, the Robert M. White Jr. Bicentennial Professor of Real Estate Finance, and Sanket Korgaonkar, an assistant professor who holds a doctorate in finance and real estate from the University of California-Berkeley.

Hosted within the Commerce School, UVA began offering real estate as a minor this past spring.

Q. In this market, is it worth compromising right now and not getting your “dream home”?

Sanderford: It’s certainly exciting to consider buying one’s dream house! However, while it’s not thrilling to attenuate your dreams, sometimes we’re forced to satisfice – or make trade-offs about what we want, what’s available, and/or what we can afford. 

A critical part of any housing purchase is understanding what you can afford. This includes down payments, closing costs, mortgage payments, operational expenses and saving for repairs or upgrades – all while keeping an eye on your family’s overall budget and goals.

During times of constrained supply and heaps of demand (like now), it’s even more important to keep budget realities front of mind as you search and bid, so that dreams don’t become nightmares!

Korgaonkar: While the level of mortgage rates has not eclipsed their previous peak, the speed at which rates have increased is unprecedented in recent times. We are already seeing a slowdown of new mortgage applications, and less foot traffic to view open houses. There are already reports of homebuilders having to provide some incentives and concessions to buyers to make sure their inventory gets sold.

While many people may be required to face this compromise, perhaps the higher rates can be offset by more ardently negotiated house prices. This will, of course, vary dramatically with location and each buyer’s specific situation. In other words, it’s not going to be easy to find a deal just yet, but there may be some around.

Q. How do rising interest rates affect the rental housing market? 

Sanderford: Rising interest rates increase the cost of borrowing for families buying homes, which in turn limits how much they can borrow. As rates rise and purchasing power diminishes, households are confronted with the trade-off of buying a less expensive/smaller house in a different location or renting something that might better meet their tastes, preferences and budgets. 

Rising interest rates also increase the borrowing costs of multi-family developers who may need to adjust rents to earn market-acceptable rates of return. For existing multi-family building owners, rising rates may put pressure on vacancy due to increased demand for rental housing.  Owners may choose to raise rents given higher demand, though not all will. Those existing building owners with variable rate debt will have the motivation to do so. 

Korgaonkar: To anticipate what might happen in the rental housing market, one needs to first consider the effect of interest rates on owner-occupied residential real estate, which influences the demand for rental housing. With mortgage-payment-to-income ratios back close to their mid-2000s peaks, it is becoming increasingly unaffordable for renters to transition into homeownership. This adds to an existing home affordability issue, particularly in large East and West coast metro areas. Note that the supply of homes for sale comes not just from homebuilders, but also from existing homeowners looking to list their homes and move. This rate of filtering – where older housing stock gets bought up by first-time homeowners, as seasoned homeowners upgrade – will also slow down as people are “locked-in” to their homes due to vastly higher rates compared to a year ago. All of this points to increased demand for rental housing. A particular source of higher demand is millennials who are ready to become homeowners, but come up against such affordability constraints.

How the cost of rent changes then depends on whether supply has kept up, and whether it can keep up with this demand. Multi-family apartment construction rebounded quickly after the Great Recession, but this new supply was concentrated at the higher end of the market. Construction of new single-family homes, or rental stock that resembles traditional homes, has been slow to recover – exacerbated by supply chain and labor shortages during the pandemic. This points us to anticipate increased rents, particularly in the single-family rental, or built-to-rent spaces. New construction will, of course, respond to these price signals, and I’m sure developers are already looking to add to the stock in these segments.

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Q. It seems we’ve been in a sellers’ market for at least two years. How long do you expect this to last? What would cause a change in trend?

Korgaonkar: As I mentioned, there are already signs that the tide is slowly turning. The rate at which this happens will vary dramatically from one geography to the other. Places where it has been difficult to add housing stock (think of the hilly Bay Area) may see the tide turn more quickly, but prices are likely to remain quite elevated given that for-sale inventory in such cities was already incredibly low coming into the rate increases.

Other places where it has been easy to build have likely seen higher construction activity (e.g., the amount of new construction along Route 29 north to Washington, D.C. has been quite noticeable since 2020). Builders will be trying to sell this new inventory, giving buyers some bargaining power. However, such areas are less prone to house price cycles and housing is generally more affordable.

Q. What are some things to consider when getting in a competitive house bidding situation?

Sanderford: The important things for me are knowing what I can afford, how long it will take to close, what I’m willing to accept in terms of demands from the seller, and when to walk away.   It’s also important to understand the transaction process and the time it takes to work through all of the contingencies and conditions of the purchase. 

Today, surveyors, inspectors, contractors, appraisers, title companies, lawyers and lenders are working on significant volumes of transactions. Having conviction when making an offer with firm knowledge of your budget and process goes a long way to being a competitive and reliable bidder. While it’s important to be a good advocate for yourself and protect your interests, it’s also good to remember everyone’s human and grace goes a long way.

Q. In order to win the bid, is waiving inspection worth it? 

Sanderford: Short answer: Rarely. Longer answer: For existing houses, unless you have the skills, materials, relationships and capital ready to remedy problems discovered after a purchase, it tends to be wiser to inspect the house and include an inspection contingency in the purchase and sale contract. 

Inspections help identify problems, while contingencies give buyers the ability to cancel the contract if they are not willing or able to fix the issues an inspection might uncover.

Beyond inspections, it pays to spend time looking at the public records for the house. Doing so helps anticipate potential problems. 

A friend recently shared that she was considering bidding on a house and discovered it was permitted for fewer bedrooms and bathrooms than she observed it contained when touring it.  After failing to find building permits existed for septic upgrades or the additional rooms, she decided there was too much uncertainty and potential expense and chose not to make an offer.

Korgaonkar: I will give you the typical economists’ answer, which is “it depends.” Naturally, if you are looking at a recently built home, then you could try and obtain an edge by waiving the inspection. But chances are that other bidders are likely to do the same, so it may not really be that helpful. It is going to perhaps help you win the bid if you are looking to purchase an older home, but of course, it is then much riskier to waive an inspection. These are the trade-offs and risks that are inherent.

Being myself a somewhat risk-averse person, I would be hard-pressed to forego an inspection if the home was more than five to seven years old.

Making an all-cash offer would help, and this is more common than one might think. About 25% of buyers made all-cash offers in 2019. One can always mortgage the property once they own it, and deploy the cash elsewhere if you believe you can earn a higher return on another investment.

Q. What misconceptions do you think buyers and sellers have about the home sale process?

Korgaonkar: The first thing that comes to mind is transaction costs. I think, and I speak a bit from personal experience, buyers and sellers don’t immediately think about the transaction costs of selling a home – broker’s fees, inspections, repairs to the house before listing and after purchase. When budgets are tight, and pocketbooks stretched, these might make a difference to what is affordable or not.

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